Deciding to invest is easy, but understanding where to invest can be tricky. With so many investment options available, many people find it confusing, and may end up investing their money somewhere that’s not right for their investment goals.
Mutual funds are amongst the most popular types of investment, with both beginners and experienced investors using them. On this page, you’ll learn everything you need to know about mutual funds, including how they work and what the risks, pros and cons are, so you can decide if mutual funds are the right investment option for you.
Mutual funds allow you to invest your money into a pool of capital together with other investors to purchase stocks, bonds or other securities
You don’t own securities from where the fund invests directly, but instead, you’re purchasing shares in the mutual fund itself
Mutual funds allow individual investors access to a diversified portfolio, and are typically professionally managed by a fund manager
Mutual funds allow you to invest your money into a pool of capital together with other investors, to purchase stocks, bonds or any other securities in a portfolio. The value of a mutual fund is known as the net asset value (NAV). This value is determined by the total value of securities in a portfolio, divided by the fund’s outstanding shares.
When you decide to invest in a mutual fund, you don’t actually own securities from where the fund invests directly; you’re purchasing shares in the investment fund itself. A share in a mutual fund is representative of an investment in different securities, as opposed to trading stocks on an exchange yourself. Investors can earn returns from mutual funds in three different ways, which are as follows:
Many funds have a fund manager who works in the best interest of the mutual fund’s shareholders. Fund managers may employ analysts to help them make accurate decisions on where to make the best investments.
Mutual funds are divided into categories, which are differentiated by the mutual fund’s portfolios and returns it seeks. The following are the common types of mutual funds:
Different types of mutual funds use different ways of investing your money, but they still have similarities in how you earn returns.
For example, let’s say you plan on investing in an investment company called “ABCInvesting”. You want to invest £2,000 into their mutual fund, and their NAV is at £20. ABCInvesting will give you 100 units of their mutual fund scheme.
After a year, the NAV of the mutual fund increases to £22, meaning that in one year, you’ve earned a 10% return on your investment for each unit you own.
Investing in mutual funds means you’ll need to determine which type of fund is most suitable for you and understand the individual risks they present and the strategy they use.
You’ll also need to consider the mutual fund’s NAV, as this may be the deciding factor for which type of mutual fund you’ll invest in. The NAV represents a ‘per-share’ value of the fund – i.e. the price at which the shares would be bought and sold – and is calculated using the following formula: Assets – Liabilities / Total number of outstanding shares.
However, sometimes a fund’s market price will trade either above or below it’s NAV, known respectively as ‘trading at a premium’ or ‘trading at a discount’. This can be due to a few factors. Firstly, supply and demand: if the fund is in high demand and low supply, the market price would usually exceed the NAV, and vice versa. Additionally, performance expectation can have an impact: if a fund is expected to perform poorly, the assets may sell at a discount, and vice versa.
Mutual funds typically have fees associated with them, and what you’ll pay, in turn, depends on the type of fund you choose to invest in.
Some funds impose transaction charges on purchases or sales in the form of commissions known as “loads”. Other funds charge a redemption fee if you sell shares you’ve only held for a short time.
You’ll also need to pay ongoing expenses to cover the fund’s operational, advisory, management and staff fees, as well as other transactional costs that come with the fund you choose.
You can purchase a mutual fund from the fund itself or through the fund broker. The price you’ll have to pay will depend on the fund’s share NAV, including any additional fees, such as sales loads.
Mutual funds are redeemable, which means you’ll be allowed to sell the shares you own back to the fund at any time you wish. However, you should consider that the selling process can take several days.
Before you purchase a mutual fund, you should read the fund’s prospectus thoroughly. A fund’s prospectus contains information about the mutual fund, including its objectives, performance, expenses and the risks it may be taking.
Although investing in mutual funds can bring you high returns on your investments, there will always be an element of risk. In fact, the higher the potential for returns, the higher the risks of an investment. That risk could include losing part or all of your investment. If you don’t want to expose yourself to risk, a savings account might be a better option for you.
Some savings accounts, such as fixed rate savings, provide a set return on your investment, eliminating the risks of investing while offering competitive interest rates.